ECB interest rate hike: how far will it go?
The president of the ECB, Christine Lagarde, this Thursday in Luxembourg.
The president of the ECB, Christine Lagarde, this Thursday in Luxembourg.JOHN THYS (AFP)

The European Central Bank (ECB) is preparing to carry out one of the most intense interest rate hikes since the creation of the euro. The entity chaired by Christine Lagarde has already announced an increase of 0.25% next July and another in September, which may even be 0.5%. And he warns that this is only the beginning of a path of increases that, according to the markets, can reach 2% in 2023. Some experts consulted even go further. The end of the era of negative rates has revealed, however, that for a rate hike it is key to prevent risk premiums from skyrocketing.

The increase in rates by the US Federal Reserve, this time of 0.75%, puts more pressure on the ECB. Even Switzerland, with inflation at just 2.9%, decided on Thursday to raise interest rates by half a point for the first time in 15 years. And England made another move and raised them by 0.25%. The ECB continues to lag behind and to calm the markets has already announced the first increases. Investors, however, immediately reacted viciously against risk premiums from the periphery. Frankfurt responded by adjusting reinvestments of maturing debt and with a new instrument to avoid debt crises, which is even seen as essential to continue with monetary normalization. In fact, Deutsche Bank believes that this tool opens a way to tighten monetary policy more quickly from September.

But how far will interest rates go? Lagarde said some hint on his blog. “If we see inflation stabilizing at 2% in the medium term, further progressive normalization of interest rates towards a neutral rate will be appropriate,” she said. That, however, gave rise to speculation and calculations of all kinds. A neutral rate is one that does not serve to expand the economy, but does not contract it either. In other words, it allows it to develop according to its potential. “This is an issue that we have deliberately decided not to deal with on the occasion of this meeting of the Governing Council. I am sure that we will discuss ad nauseam whether it is 0.96% or 1.97% or more, below or whatever”, affirmed the Frenchwoman after the last meeting of the ECB leadership.

The growth question mark

Even so, the members of the Governing Council have made their calculations. The pigeons are more around 1%, while the hawks advocate 2%. “The idea is to achieve a neutral rate over time. I have seen it estimated in Europe between 1.25% and 1.5%, while it should be higher in the United States, around 2.5%”, says Francesco Papadia, from the thinktank Bruegel. The influential German Ifo goes even further. “Our hypothesis is that the ECB interest rate will be at 2% at the end of 2023 and the 10-year German bond rate at 2.5%. We believe these steps are the right ones to keep inflation and inflation expectations in check,” says Timo Wollmershüer, Head of Research and Outlook. The feeling is, however, that the ECB is running late.

For now, analysts are around the generous range drawn by the governor of the Bank of France, François Villeroy de Galhau, between 1% and 2%. Nomura believes that euro zone rates will be around 1.25% next year, while Deutsche Bank believes it will be much more aggressive and will be around 1.75% by the end of this year. The professor at the Graduate Institute of Geneva, Charles Wyplosz, goes much further and even believes that the Eurobank will have to reach or exceed 3% to combat inflation. A member of the ECB, however, suggests that the pace and intensity of the increases should be in step with the economic and financial situation of the countries. “What would happen if in the middle of the increases there is another shock What hits the economy?” he asks. The other great variable, that of risk premiums, has been stifled for now with the announcement of the new instrument, although financial sources warn that the markets will soon demand to know its details.

He knows in depth all the sides of the coin.


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